The Startup Meant to Reinvent What Bitcoin Can Do

A company given $21 million by leading Silicon Valley investors aims to extend Bitcoin’s functionality so it can power much more than just payments.

LinkedIn founder Reid Hoffman announced an unusual new investment late last month. He and other Silicon Valley luminaries, including Sun Microsystems founder Vinod Khosla, sunk $21 million into a company that may never have to make a profit to be successful.

That company is called Blockstream. Hoffman and others backed it in an effort to give a technological shot in the arm to Bitcoin, a digital currency built upon software that uses cryptographic transactions to prevent counterfeiting without the need for any central authority (see “What Bitcoin Is and Why it Matters”).

Blockstream is working on technology that will use the code that underpins Bitcoin to secure other kinds of assets, such as contracts or ownership of stock. The company’s technology could also provide workarounds to shortcomings in the design of Bitcoin.

Bitcoin has come a long way since its obscure debut in 2009, and the 13.5 million bitcoins in circulation are worth $4.7 billion. But the currency has yet to become widely used, and Blockstream’s founders and investors say significant technical improvements are needed for that to happen.

“Blockstream will play a huge role in helping it maintain its momentum,” Hoffman wrote in a blog post on his investment. He said that the company will operate in a similar way to Mozilla Corporation, which produces the Firefox Web browser and related technology but is owned by a nonprofit foundation. However, if Blockstream is successful in helping Bitcoin catch on, other Bitcoin companies that Hoffman and his fellow investors have backed stand to benefit.

Bitcoin startups have received hundreds of millions from investors in the past few years (see “Bitcoin Hits the Big Time”). But few resources have trickled down to support work on the core technology that makes Bitcoin work. Startups have focused on building products on top of Bitcoin, such as online payments services. It has fallen mostly to a band of unpaid coders to maintain the core technology that underpins how Bitcoin operates (see “The Man Who Really Built Bitcoin”).

That community has been unable to work on improvements to Bitcoin’s design, says Adam Back, a cryptographer and cofounder of Blockstream. “Core development has been quite conservative and focused on security and stability,” he says.

Blockstream won’t be helping out with the core Bitcoin code, though. Instead it is building on top of it using what are known as “sidechains.”

At the heart of Bitcoin’s design is what is known as the blockchain, a digital file maintained by computers around the world that records every Bitcoin transaction. Bitcoin’s most novel feature is that everyone can trust the blockchain’s record, even if they don’t trust every individual contributing to its upkeep or using Bitcoin.

A sidechain can also record Bitcoin transactions, but it can have different functions as well. Blockstream has developed a way to safely move bitcoins back and forth between the blockchain and sidechains in order to add new functionality to Bitcoin transactions.

For example, Bitcoin transactions currently take an average of 10 minutes to be confirmed, which is inconvenient when paying for goods and services. It would be possible to create sidechains specialized to processing Bitcoin payments instantly, says Back.

Sidechains can also be used to apply the math-backed mechanisms that protect Bitcoin against counterfeiting to other assets. For example, sidechains could be created to handle issuance of company stock as a cheaper, but still trustworthy, alternative to paying a conventional financial company to oversee the record keeping.

Ideas like that are not only found amongst Bitcoin enthusiasts. In October, the chief information officer of banking giant UBS said that he believed that blockchain-style technology could be used to simplify financial trading, and the settlement of funds between banks. The chief executive of the U.K.’s financial regulator, the Financial Conduct Authority, has said he plans to explore similar ideas.

Gavin Andresen, chief scientist for the Bitcoin Foundation, and the primary maintainer of Bitcoin’s code, says Blockstream’s proposal is a good one. Bitcoin might come to power a diverse collection of services by the use of sidechains to cheaply provide trust and security, he says.

Emin Gün Sirer, an associate professor at Cornell University, says that sidechains could also help reverse the fragmentation that has seen many me-too digital currencies spring up in the wake of Bitcoin. Currencies such as Doge coin, Master coin, and Zero cash range from in-jokes that gained surprising momentum to serious attempts to improve on Bitcoin’s design—for example, by making transactions truly anonymous.

Today those alternative currencies are independent of Bitcoin’s large community of people and ample resources. Sidechains provide a way to create alternative digital currencies and other experiments without giving up the stability that comes from building on the Bitcoin ecosystem, says Sirer. “There is consumer demand for them, and many bring something technically interesting to the table.”

Back says his company is working on its first prototype sidechains now, and will release them next year in partnership with companies interested in using the technology. Blockstream will also release tools to allow people to make their own sidechains.

However, a change needs to be made to Bitcoin’s code for the process of transferring bitcoins to sidechains to be as secure as a normal bitcoin transaction. Blockstream has a workaround in place that Back says is good enough for people to start experimenting with sidechains as soon as the technology is released. Once companies understand the potential of sidechains, Blockstream will be able to earn revenue through consulting services, he says.